Thinking like an economist

Thinking like an economist

KEY CONCEPTS

• The problem of scarcity

• Scarce resources and production

• Economics: the study of scarcity and choice

• The methodology of economics

• Hazards of the economic way of thinking

• Why do economists disagree?

THE PROBLEM OF SCARCITY

• Scarcity forces us all to make choices as we never have the amount of goods and services we want:

–individuals: a bigger flat screen TV etc.

–governments: improved schools, highways and high speed internet network (NBN) etc.

•Economics aims to explain what occurs as a result of scarcity because wants are forever greater than the available resources.

•Economists aim to explain how individuals, groups and society can:

–satisfy their wants given the resources at their disposal.

SCARCE RESOURCES AND PRODUCTION

•Scarcity is also called the economic problem.

•Individuals and countries never have as much of all the goods and services they would like because there are insufficient resources to produce such goods and services.

SCARCE RESOURCES AND PRODUCTION

•Resources are the basic inputs used to produce goods and services.

•Resources are also called the factors of production and are split into three main categories:

THREE CATEGORIES OF RESOURCES

RESOURCES: LAND

•Any natural resource provided by nature used in the process of production:

–forests, minerals, wildlife, oil, rivers, lakes and oceans.

•May be renewable or non-renewable.

RESOURCES: LABOR

•Measured by the number of people available for work and the number of workers.

•The mental and physical capacity of workers to produce goods and services.

•These include:

ENTREPRENEURSHIP

•Entrepreneurship is a special type of labor.

•This is the creative ability of individuals to organize and manage the combination of resources to produce goods and services.

•An example of this: Edward Joseph Nathan

RESOURCES: CAPITAL

•Capital relates to human-made goods that produce goods and services.

•Capital is used to produce the goods and services desired, such as a factory that produces televisions.

•Unlike in accounting, money is not included in the economic definition of capital as money is a measure of value placed on goods.

ECONOMICS: THE STUDY OF
SCARCITY AND CHOICE

•Economics is the study of how society chooses to allocate its scarce resources to the production of goods and services in order to satisfy unlimited wants.

•Society makes two types of choices:

–economy-wide (Macro)

–individual (Micro).

TWO BRANCHES OF ECONOMICS

THE METHODOLOGY OF ECONOMICS

•Economists (like other scientists) use scientific method.

•Scientific method is a step-by-step procedure for solving problems.

THE STEPS IN THE MODEL-BUILDING PROCESS

MORE ABOUT MODELS

•A model is a simplified view of reality.

•It sets out the relationship between variables; causes and effects.

•A model is only valid when it enables economists to forecast or predict the results of various changes in variables.

‘Models should be as simple as possible, but not any simpler’

- Albert Einstein

EXAMPLE: PETROL CONSUMPTION

HAZARDS OF THE ECONOMIC
WAY OF THINKING

•There are two potential problems to be aware of:

–the ceteris paribus assumption

–possible confusion of association and causation.

CETERIS PARIBUS

•Ceteris (pronounced ‘keteris’) paribus

–Latin: ‘other things remaining unchanged’.

•It enables economists to see how a change in one variable affects the overall outcome.

•Reason: if all the variables change at the same time, there is no way to know which one caused the change.

ASSOCIATION VS. CAUSATION

•We cannot always assume that when one event follows another, the first caused the second.

•For example, assume exports from Indonesia rose last month. Two events might be associated:

–the hole in the ozone layer grew last month.

–currency movements reduced the cost to Australians of buying Indonesian goods.

•But are they both possible causes?

WHY DO ECONOMISTS DISAGREE?

•As in other professions, disagreements occur.

•A major reason for disagreements in economics is due to the assumptions made about human nature.

•Modelling more elaborate assumptions about human nature has resulted in the growth of behavioural economics.

BEHAVIORAL ECONOMICS

POSITIVE ECONOMICS

•Positive economics is an analysis limited to statements that are verifiable.

•Positive statements are testable - they can be proven true or false.

•Examples

–‘Airbags save lives.’

–‘Smoking is harmful to your health.’

NORMATIVE ECONOMICS

•Normative economics is an analysis based on value judgements.

•Normative statements cannot be proven by facts to be true or false.

•Examples:

–‘Every teenager who wants a job should have one.’

–‘The government should allocate more money to education.’